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10.27.2013

Is Dave Ramsey right?

I'm a regular listener of the Dave Ramsey Show, the radio advice show that's all about getting out of debt.

Ramsey's recurring spiel is to live on rice and beans until you have all your debt paid off, then pay cash for everything, invest in growth mutual funds, and give generously to charity. So far, so good.

But there are a few details with which I take issue:

1) 401(k) match: Ramsey recommends not saving or investing at all beyond a $1000 emergency reserve until you have paid off all of your non-mortgage debt. This includes 401(k)s. This is horrible advice to forgo maximizing your 401(k) up to the company match amount. You're giving up free money, an instant 100% return. You'd even be better off taking the match, then doing an early withdrawal of your contribution and paying taxes and penalties, and using that money to pay down your debt. Not that I'd recommend that.

2) Mortgages: Ramsey recommends only using 15-year fixed-rate mortgages with payments equal to or less than 25% of take-home pay, if not paying cash outright. While a noble goal, this is highly unrealistic in a world where house prices are set by other buyers paying 40% or more of income on 30-year mortgages. I'm all for paying cash for a house in San Diego where median home prices are over $400,000, but then I'm all for regular guys getting laid by supermodels too.

Let's say you have a household income of $100,000, far above the San Diego median of $60,000. Your take-home pay after taxes and other deductions is about $5600 a month, if you don't contribute anything at all to a 401(k). 25% of that is $1400 a month, which will service a $200,000 loan for 15 years at 3.25%. You've got a well above average income, but you can afford only half of an average house. Most Ramsey followers in expensive markets like California would have to be permanent renters at least until late in their careers, even though early home ownership has historically been a pretty significant contributor to household wealth.

First, you don't have to quit your job. You can do a hardship withdrawal. And if you have no assets and a lot of debt, it shouldn't be too hard to come up with a "hardship" story.

But to your broader point, 401(k)s are protected in a lot of ways that ordinary bank and brokerage accounts aren't. They are shielded from lawsuits in most cases, and they don't count against a lot of means-tested government programs like tax deduction phase-outs, food stamps, and college financial aid.

It's certainly possible that our bankrupt government will eventually seize retirement accounts, or force-convert them to negative-real-yield Treasuries. But in that case you'd better watch out for your non-retirement accounts too. If a wealth tax comes, I wouldn't be surprised to see it hit non-retirement accounts harder than retirement accounts. After all, lots of voters have $200,000 in a 401(k), but only the evil rich have $200,000 in non-401(k) cash and stocks.

Then there's the diversification problem. If you're going so paranoid that you don't want 401(k)s or US-based bank or brokerage accounts, you can't really have overseas accounts either because the thuggish US government is now tracking and taxing all worldwide accounts of its citizens (unlike 99% of other countries which don't consider their citizens financial slaves). So you're basically limited to overseas property and overseas precious metals. I'm not ready to go zero-weight on US stocks. Yet.

I have a number of clients who listen to Ramsey. Some of his advice I agree with, some I disagree with. I tell all my clients to maximize IRA or 401(K) deductions.I recognize the dangers of IRAs and 401(K)s. I will forward you some old posts of mine on this.